In the context of the recent Israeli-Palestinian military conflict, the Arab League economic boycott of Israel, while moribund, lingers as a symbolic gesture of Arab protestation. US entities still face the risk of economic penalties and/or the loss of other trade-related advantages if their products or services become part of any boycott. Given recent events in Gaza and initiatives such as Boycott, Divestment and Sanctions Movement (BDS), increased requests and pressure to participate are likely in the near term.
Even before Israel’s founding in 1948, many Arab countries sought to economically undermine Israeli business in Palestinian territories. Following the war of Israeli independence, a formal boycott targeted Israel, non-Israelis economically tied to Israel, and perceived Israeli supporters. Boycott enforcement was left to member state’s discretion.
In 1977, the US Congress made boycott cooperation illegal for US companies and authorized imposition of civil and criminal penalties against violators. Embedding legislative intent in the Export Administration Act (EAA) and the Ribicoff Amendment to the 1976 Tax Reform Act (TRA) gave Departments of Commerce and Treasury oversight and enforcement for boycott issues. Rules promulgated by Commerce through the Export Administration Regulations (EAR) prohibit boycott compliance, whereas the relevant portion of the Internal Revenue Code (IRC) does not prohibit but penalizes compliance.
Both the EAR and TRA anti-boycott provisions are complicated in practice, outlining a range of categorical violations rather than a control list or embargo destinations. In the case of the EAR, there are six categories of prohibited conduct and a corresponding range of singularly outlined exceptions. The IRC captures non-prohibited but actionable behaviors under the concept “boycott participation,” a designation more reminiscent of maritime impressment than sanctions busting.
For EAR anti-boycott violations, a full spectrum of penalties apply:
Civil: $250,000 per violation (or twice the value of the transaction, whichever is greater)
Criminal: Penalties of $1 million per violation or 20 years imprisonment.
Under the TRA, US government tax benefits for exporters can be voided by boycott compliance. These benefits include, among others, a foreign tax credit, the benefits for foreign sales corporation (FSC) since repealed, and a tax deferral available to US shareholders of a controlled foreign corporation (CFC).
Regulations require US persons to report boycott compliance requests. Commerce and Treasury offer compliance reporting forms, which in the case of Treasury includes a thoughtful appendix to a tax return. The reporting data allows for managing anti-boycott risk by being conveniently disaggregated to reveal requesting country and the gamut of boycott requests categories.
While not as prominent as EAR export control violation enforcement actions, anti-boycott busts are not insignificant. In the case of TRA violations, the loss of tax-related deductions and increased risk of future scrutiny are substantial indirect costs. Economic Statecraft
The historical trend correlating increased anti-boycott requests with Palestinian-Israeli conflicts is palpable. Since the 2008-09 Gaza War, for example, the average boycott compliance request rate was 697 requests per year, a 375 request increase above the previous three-year period. BIS fines from 2013 were the largest since 1996.
In February 2014, Israeli Foreign Minister Avigdor Lieberman announced creation of a new interministerial team to fight efforts to boycott Israel. Concurrently, US House Representatives Peter Roskam and Dan Lipinski introduced anti-BDS legislation barring federally-funded US universities from joining boycotts of academic institutions. Although their bill failed to pass, it signals survival of US anti-boycott legislation. Drafts of other bills to augment current US anti-boycott laws and regulations are circulating. Given the complexity of these laws, it is important that US companies ensure compliance through enhanced awareness, training and due diligence.
The Cold War Reprised
Since the collapse of the Soviet Union, analysts have labored under the protracted notion of “post-Cold War” as the descriptive term to characterize the past twenty years. Recent events along the East-West axis have tested this moribund concept: it would seem we are very much back in the Cold War.
With the annexation of Crimea, Russia’s alleged involvement in the downing of a passenger airliner, accusations of Russian abrogation of the Intermediate-Range Nuclear Forces (INF) and Conventional Forces in Europe (CFE) treaties, and its variegated support for pro-independence insurgents in eastern Ukraine, Moscow is regaining its former Soviet footing. In a response reminiscent of the Coordinating Committee on Multilateral Export Controls (COCOM), the West, the U.S. government and the European Union (EU) announced further sanctions against Russia for the annexation of Crimea and alleged involvement in eastern Ukraine.
Technology denial was the basis upon which the Western Cold War offensive was waged. Russia’s post-Soviet export control rehabilitation through the 1990s, including association in the multilateral export control arrangements such as the Wassenaar Arrangement., increased military and dual-use trade flow with the West.
Today, the West is reprising its practices of technology denial. The newest sanctions are again targeting technology transfers, including oil and gas, arms, and dual-use products. There are considerable implications for EU and U.S. businesses. Given the present spiral, it is very unlikely economic relations, let alone political, will be normalized in the near-term.
Supply Chains Delinked
From satellites to shipbuilding, Russian high tech production has become increasingly integrated into Western supply chains since the dissolution of the Soviet Union. Russian military production has been deeply connected with Ukrainian suppliers, a legacy of Soviet-era military production. To the degree sanctions will impact supply chains for their military production and next generation research, Moscow will be very keen to acquire requisite technologies. Non-Western suppliers are not really options given quality and reliability concerns. Given this gap, Russian initiatives to acquire these technologies will increase, thereby posing risks to EU and U.S. producers and suppliers.
Be prepared for a long-haul.
Yesterday, President Vladimir Putin directed his government to begin imposing a range of counter-sanctions, such as banning Polish apple imports. More seriously, there has also been discussions about banning trans-Siberian overflights.
Record high popular support among Russians for President Putin makes him an entrenched recusant. His negotiating style will become increasingly inflexible, particularly given the sunk costs to Moscow of annexing Crimea.
The larger U.S. and EU strategic context suggests an intractable medium-term. The continued crisis in eastern Ukraine and Russia’s alleged INF violations portend a steady-state sanctions future, and familiar in its Cold War strictures of economic statecraft. Even with a magical volte face on support for eastern Ukraine, unrolling sanctions would take significant time.
Companies with business in Russia should adjust accordingly. Likewise, companies and financial houses should expand their know-your-customer (KYC) risk management protocols to include all Russian end-users.
A Modi-Fied India
A welter of activity is taking place within the Government of India (GOI) in the first 30 days of the new Narenda Modi government taking over. The right-wing Bharatiya Janata Party (BJP), under Modi’s leadership, swept into power with 282 seats in the 542-member Lok Sabha (House of Representatives) on 16 May. Counting its allies in the National Democratic Alliance (NDA), BJP holds 336 of 543 seats. This gives Mr. Modi a mandate that is unprecedented for any Indian government since the 1980s.
Markets reacted extremely positively to Mr. Modi’s election, and the buoyancy continues as we hear daily reports of how campaign themes of efficient governance, timely implementation of programs and accountability are being fulfilled in the new government through major institutional and policy changes.
Foreign investors in India are changing investment strategies to favor domestic-oriented companies, mid-cap stocks and state-owned enterprises, based on expectation that the government will incentivize/force better performance from these. India has received net foreign portfolio flows of $10 billion so far this year, more than other emerging markets in Asia. Planned appointment of a Special Envoy for Development Diplomacy will further facilitate foreign investment into India, especially from Asia and the Gulf Cooperation Council (GCC).
Foreign policy initiatives include diplomatic overtures to Pakistan, Bangladesh and Bhutan; hosting delegations from France and China; plans for the Modi’s visit to Japan in August and the United States in September. Public expectations of positive change in governance and market expectations about rationalized policies remain high.
Streamlining the World’s Largest Democracy
A smaller cabinet of 46 Ministers and Ministers of State, with all major portfolios firmly in BJP hands, suggests few options for allies to interfere on major policy decisions. This has been accompanied by the dissolution of the system of formal and highly inefficient coordination between Ministries through Empowered Groups of Ministers and Groups of Ministers (EGOMS & GOMs).
In his first interaction with 70 senior bureaucrats across the Ministries, Mr. Modi encouraged every department to identify and repeal 10 rules or processes, and even archaic Acts that are redundant and would impact efficiency. Each Ministry was to provide a 10-slide 10-minute presentation to him, summarizing the top-10 decisions that can be implemented without delay, decisions that need to be re-worked, and the top-5 priorities/projects for the Ministry in the next 365 days.
Ministers holding multiple portfolios are expected to sort out matters informally. As a result, the long-delayed environmental clearances for projects like a naval base in Karwar used by the navy and civilian ships intended to take the load off Mumbai port, and a radar station on Narcondam island in the Andamans, have been issued when the Environment Minister and the Power Minister met over coffee. The Environment Ministry is also trying to fast-track roads and defense projects classified as strategic. Radar and telecommunications projects within 100 km (62 miles) of the 4,000-km (2,500-mile) border with China, large parts of which are disputed, will be put on an automatic approval list.
The Finance ministry is keen to allow at least 49% investment in all sectors, barring a few strategic ones, to stimulate overseas interest. This 49% investment will be allowed through the automatic route, without requiring time-consuming government approval. Defense, railways, e-commerce and media benefit significantly from this type of liberalization. India’s defense budget was more than $30 billion last year, and it already imports more weaponry than any other country.
The new government is focused on the creation of dedicated regional hubs for manufacturing, flexibility in labor laws, a safety net for workers, and rationalization of taxes. The government is also looking at tax measures that would remove hurdles in the way of manufacturing without hurting revenue. Such changes would be in line with the government’s resolve to move to a unified goods and services tax (GST) regime expeditiously.
Expanded Foreign Cooperation
A multi-billion dollar infra-fund amounting to US $4-5 billion is likely to be set up within 6 months to incentivize foreign and domestic investments into the infrastructure sector. Reportedly, investors will be able to avail of a minimum commitment guarantee of 3% on any PPP (Public Private Partnership) project. Japanese and Korean investors have already shown interest in participating in the fund.
The government has also decided to form a Nuclear Insurance Pool which will have a number of stakeholders, including General Insurance Company, the only re-insurer in the country, to meet the requirement of huge financial cover in case of a mishap. The volume of the pool will depend on how the government contributes to it for every project. This is expected to pave the way for accelerating work on power reactors at Kudankulam (Russia), Jaitapur (France) and kick-off planned nuclear projects with US companies.
The first budget of the new government is likely to be presented on July 11. Most India-observers expect this to provide the true roadmap for national economic priorities – beyond clearing the back log of projects and initiatives held up by the past regime. Change momentum is building, and businesses from Japan, US, Germany UK, Singapore and China are showing their willingness to do business with the Modi-fied India.
The Return of Cold War Sanctions?
Cold War Sanctions
I recall vividly the frustration of making a phone call within the Soviet Union during 1988. It was like trying to hear someone underwater with the static of a jet engine. “Ivan, hello…..ssssssssss…what ….ssssss…. can you hear me?”
At the time, the Soviet Union lacked modern telecommunications systems. Throughout the Cold War, the U.S. and Western allies maintained trade controls that restricted strategic items, including telecommunications equipment, from sale to the Soviet Union and Warsaw Pact countries. The U.S. and its allies worked through the Coordinating Committee for Multilateral Export Controls (COCOM) to ban exports of any items that might enhance Soviet military capabilities. This blockade deprived the Soviets of access to Western technology.
As the Cold War ended, the U.S. gradually lifted these trade controls, and COCOM was disbanded. U.S. and Western export controls shifted from blocking strategic trade with former communist states to controlling trade in dual-use technologies that could be used by rogue states for chemical, biological and nuclear weapons. Russia became a partner in these nonproliferation efforts, joining the Missile Technology Control Regime and other nonproliferation arrangements. The U.S. even worked with Russia to implement a modern regulatory system of dual-use export controls.
Scientific collaboration and academic exchanges flourished. The U.S. national laboratories engaged their Russian counterparts in cooperative projects on previously forbidden technical issues. The U.S. reached out to Russia’s aerospace entities, forming commercial joint ventures for trade, space launches, and cooperation on the International Space Station.
The Collapse of U.S.-Russia Relations
Recent years have seen a decline in U.S. relations with Russia. Issues complicating relations presently include differences over the handling of the civil war in Syria, Iran’s nuclear program, the Caucasus, Libya, and the political direction of Ukraine. While the broad Cold War trade controls of yesteryear are dead, they have been replaced with a new type of micro sanctions and targeted controls.
With Russia’s recent annexation of Crimea, U.S.-Russia relations are matched in a contest of mutual sanctioning, though so far mostly symbolic. The U.S. imposed three rounds of sanctions targeting individuals and institutions. The sanctions list has steadily grown, and the U.S. is employing more restrictive export controls. The State Department and the Department of Commerce announced their intent in April to deny exports to Russia of any products and technologies that “contribute to Russia’s military capabilities.” The U.S. Department of Energy (DOE) implemented a ban on Russian scientists working in its laboratories and restricted DOE travel to Russia except for projects related to nuclear security and nonproliferation.
Not surprisingly, Russia has countered, imposing similar travel bans on members of Congress. Deputy Prime Minister Dmitriy Rogozin, a target of U.S. sanctions, stated Russia may withdraw from the International Space Station. In response to U.S. sanctions, the Export Control Commission (ECC), also chaired by Rogozin, is likely to restrict exports of other Russian strategic items to the U.S.
More critically, Russia may end its supply of RD-180s, the workhorse rocket engines used to launch U.S. commercial and military payloads. Currently, the U.S. only has a two year supply of RD-180s. Alternatives to this engine include the untested SpaceX Falcon Heavy or the Aerojet Rocketdyne AR-1. The AR-1 would not enter production for four years, assuming government funding is quickly approved. Losing the RD-180 supply places severe limitations on the U.S. ability to address launch requests. Are More U.S. Sanctions Coming?
U.S. success in coordinating a multilateral response is far more unlikely today than during the Cold War era. Russia will use its gas and other resources to drive a wedge between the U.S. and its European partners to counter hard hitting sanctions. Its leverage against U.S. and E.U. sanctions has been enhanced by signing an agreement to provide $400 billion in natural gas to China over 30 years.
This agreement with China does not completely remove Europe from Russian strategic planning, though. Russian gas shipments to Europe net $30 USD more per thousand cubic meters than to China, meaning Russia will not pivot to China exclusively in the short term. Likewise, Europe receives 30% of its natural gas supply from Russia, which cannot be easily replaced. Russia demonstrated this leverage on June 16 when Gazprom cut off natural gas supplies to Ukraine. Russia’s energy resources provide the Kremlin with a tool to thwart a hard-hitting and coordinated sanctions response.
Russia’s resource wealth and global business connections will limit the impact of sanctions and temper the fervor of U.S. partners to expand sanctions. Europe is too dependent on Russia and too exposed at the moment to join a strong multilateral sanctions regime. Increased U.S. sanctions and tighter Russia-focused export controls are likely. The U.S. has a long history of using unilateral sanctions and export controls to press foreign policy goals and to signal its disapproval of other government’s behavior. The U.S. propensity to sanction has not diminished.
Regardless, Russia is not going to reverse on Ukraine. Putin considers its future central to Russia’s core national interests. Russia will continue to meddle to prevent a united Ukraine that leans towards Europe.
As a result, the U.S. will continue to impose additional targeted sanctions and tighter export controls that signal disapproval of Russia’s interference in Ukraine. In turn, Russia will use its limited levers of influence to block transfers of aerospace products and technology to the U.S. while at the same time seeking to create division within the Western allies and any coordinated response.